What Can One Learn from Carillion?

April 11, 2018 / Contractual Issues, General

Blog Author: Peter Hibberd

The collapse of Carillion was a shock and affects many within the industry, not least sub-contractors and suppliers. It was a shock because, despite the warnings of some commentators, large companies supposedly should not go into compulsory liquidation. It is in that belief that a sub-contractor is generally happier to work for large companies. Carillion’s collapse shows that belief, if not entirely misplaced, to be one that cannot be taken for granted. Just because a company is large it is not necessarily safe; precautions are always necessary.

When insolvency occurs all the subcontractor has to do is seek recompense from the trade credit insurance it took out to cover such an eventuality. But oh dear, for many there is no such insurance in place. This may be so because of lack of familiarity with its availability or more likely because of cost. It is another cost eating away at profit margins and also potentially making the bidder less competitive. So if trade credit insurance is not the answer, what is? When considering the options, one must accept two fundamental points; they all involve cost and none of them is absolutely foolproof but they can both individually and collectively reduce payment risk.

Before entering into contract with an organisation, regardless of size, ascertain its current financial position, its current payment practices and whether it is either growing or shrinking too rapidly – its cash flow may be under stress. It is also important to look at one’s own portfolio of work for too many eggs in one basket can be catastrophic in the event of payment delays, let alone insolvency on the part of the payer.

Now to look at the contract itself: firstly, the sub-contract should be an accepted industry standard form appropriate to the main contract, for example a JCT Standard Building Sub-Contract (SBCSub), JCT Short Form of Sub-Contract (ShortSub) or JCT Sub-subcontract (SubSub). The benefit of using such a form arises in a number of ways, the first is the way it governs insolvency, which is defined term. Secondly, under SBCSub, where the main contractor becomes insolvent the sub-contractor’s obligations under the sub-contract are immediately suspended, which avoids increasing the risk. Then following a three week moratorium it has a right to terminate its employment. The contractual consequences of the termination are spelled out and importantly the sub-contractor retains access to the site to remove its materials and equipment etc. With regard materials supplied it is always worth considering making them subject to a ‘retention of title’ provision.Such unfixed materials need to be clearly identifiable but this does mean the subcontractor can repossess them in the event of payment default, therefore reducing its potential loss.

Although the contractor has an obligation to inform the sub-contractor immediately that it is insolvent or becomes subject to proceedings related to such an event this may not happen as required; sub-contractors should always be aware of the possibility of pending insolvency. There usually are signs. Now although such contract termination provisions help sub-contractors by providing a framework to deal with insolvency on the part of the payer, these may be of limited use in their recovery of loss, and in cases such as Carillion, certainly will be. So what else can be done?

Under any contract it is important to ensure good cash flow. An aspect of that is the period between payments and the period for payment. Under JCT contracts the payment regime is set out and works on a monthly cycle unless the standard form is amended in the case of SBCSub or a longer period is inserted in the recitals of either ShortSub or SubSub. Extending the payment cycle increases risk in the event of payment default, which is inevitable when the payer becomes insolvent. Limiting the risk by shortening the payment cycle is worthwhile but not always possible but an extension of the payment period to say 90 or 120 days is dangerous. The sub-contractor is exposed not only for the work executed and not yet certified but also for certified work until it is paid: even then the certified payment may include retention. Frequently, retention is held under a sub-contact and, where it is, sub-contractors should ensure that the retention percentage is not increased from the default position, ideally secure a reduction. Also ask for retention to be placed in a trust account. Alternatively, consider using a retention bond, which means payments are made without retention and the payer has security of the bond in the event of the sub-contactor’s default. Retention bond provisions are included in SBCSub, because the size of sub-contract may justify such an approach.

Another way of reducing risk is to seek advance payment from the contractor, which is secured by the sub-contractor obtaining an Advanced Payment Bond from a surety for the benefit of the contractor. Examples of all above bonds can be found in the JCT standard form of building contract.

The problem for sub-contractors carrying out relatively small packages of work is that negotiating different terms, taking out bonds and securing parent company guarantees seldom appears worthwhile and the concept of project bank accounts seldom arises. If the risk has to be taken then at least make sure of the contractor’s financial soundness and, as best one can, create a diversified portfolio of projects. Sub-contracting is a risk business and payment risk must be reduced to a financially manageable level. Remember ‘pay when paid’ means little when the payer is insolvent.